Last week, prices of several commodities declined abruptly: silver lost over a quarter of its value from April 29 to May 5, while oil plunged nearly 10% over the same period of time. The immediate question on the minds of many investors was whether the commodity run was over. And while the Federal Reserve has indicated that that it will deliver a soft landing to QE2, instead of an abrupt end that would have sparked inflation and sent commodities soaring, the signals of the Fed were by no means thought to have such a profound impact on prices. Instead, as this note shows, the sudden drop in commodity prices is consistent with quantitative research and may show that commodities are now chiefly traded using quant analysis.
Specifically, according to the quantitative factor analysis, many commodities tend to consistently outperform the S&P 500 stock index in April, and underperform the index in May and June. Silver, in particular, tends to deliver high April returns in excess of the S&P 500. Adjusted for macro risk, silver averages a 4.8% return in excess of the S&P 500 in April with 96% statistical confidence. The risk-adjusted return of silver then drops to a statistically-insignificant -0.2% in May, followed by a -1.2% underperformance in June (the latter with just 68% probability).
Similarly, oil tends to deliver positive returns relative to the S&P 500 in April, but to underperform the index in May, and particularly in June. In fact, in an average June, oil delivers 2.5% less than the S&P 500 with 97% statistical confidence! Such expectations certainly reduce the outlook for oil and could be a sufficient trigger for the drop in prices. In comparison, gold, which like silver significantly outperforms S&P 500 in April, keeps steady in May, on average earning a positive if statistically insignificant 0.3% over the S&P 500. Yet, like many other commodities gold also tends to perform poorly in June, coming 2.2% shy of S&P 500 with 87% confidence, potentially explaining its performance. Other commodities, like natural gas, also follow a similar quantitative pattern.
The bleak quantitative outlook for May and June may have prompted enough investors to sell off their silver holding at the end of April. The latest activity in the commodity space may just serve as an indication that quantitative trading may have taken over commodity investing and is now the dominant force behind the markets.
Irene Aldridge is a quantitative portfolio manager at ABLE Alpha Trading, LTD. She is also a co-author of the Quant Investorâ€™s Almanac 2011: A Roadmap to Investing (Wiley, 2010), an up-to-the-minute compendium of economic announcements upcoming in 2011, and a summary of responses of various equities, foreign exchange and other securities to different economic announcements.